Boost to house supply may overheat economy, watchdog warns

Rapidly boosting the construction of housing supply may cause the economy to overheat, thus requiring counter-cyclical measures such as higher income taxes, a Government economic advisory board has warned.

In its latest fiscal assessment, the Irish Fiscal Advisory Council (Ifac) suggests there is an increased risk the economy may experience overheating in coming years, as it called on the Government to publish a medium-term economic plan.

Speaking on Tuesday, Seamus Coffey, chairman of Ifac, said the economy is "close to its potential", and could continue on in a stable position. However, if a "rapid – albeit necessary" response from the construction sector to the current housing shortage was to arise, Mr Coffey warned this could risk the economy overheating, unless it was offset by countercyclical measures.

Construction jobs

While the council acknowledged that a stronger supply response was needed to keep house prices and rents in check, it said that with the labour market converging on full employment, too swift a pick-up in construction jobs could bid up wages and erode competitiveness, similar to what occurred in the mid-2000s just prior to the crash.

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Mr Coffey said this could mean raising taxes on the consumption side, such as income taxes, to moderate demand. The Government expects about 19,000 new homes to be built this year, but the Banking and Payments Federation Ireland said about 40,000 units may need to be built annually to satisfy the current level of demand.

Budget measures

In an assessment of the Government’s recent budget, Mr Coffey pointed to the Government’s “prudent” economic and budgetary management. However, he did express a concern that some of the revenue-raising measures in Budget 2018, which were introduced to offset the faster-than-allowed growth in expenditure, may not have the same yield as estimated for 2018 over the long run.

In particular, he said the projected yield from the increase in commercial property stamp duty to 6 per cent may be “relatively optimistic” in terms of its long-run impact, given the sector is at a high point. However, a reduction in tax revenues “could happen for a good reason”, if the increase in stamp duty in commercial property saw resources transferred to the residential property sector, he said.

Debt reduction

Looking ahead, the council said the budget plans allowed for a gradual pace of debt reduction; moderate increases in current expenditure; and a ramping-up of public investment to rates that are among the highest in the EU, while also complying with the requirements of the fiscal rules.

On tax yields, Ifac doesn’t support the view that tax revenues are under-performing, noting that when PRSI revenue is added to the exchequer returns, the underperformance “evaporates”.

“And now you have an out-performance,” Mr Coffey said.

Corporation tax now accounts for 16 per cent of total tax revenues, which, apart from the run-up to the crash, is “unprecedented” Mr Coffey said, adding that given it is “highly concentrated”, and dependent on revenue of multinationals, it remains a concern. Specific concerns include potential US tax reform; a change in direction of the OECD base erosion and profit shifting (Beps) project; and the “possible but unlikely” introduction of tax harmonisation in Europe.

Ifac also wants to see the Government set out a “credible” plan for the medium term, so that a “procyclical pattern of budgetary increase does not occur as has often been the case”.

IN BRIEF: WHAT IFAC SAYS

- A sharp uptick in construction activity could risk over-heating the economy which would require higher taxes to counteract the impact

- Tax revenues are not under-performing; when PRSI is included the lag “evaporates”

- Concentration of corporation tax remains a risk

- Expectations for increased commercial property tax revenue may be “relatively optimistic”

- Government needs to publish a medium-term economic plan

- Ireland’s net debt burden (as a percentage of GNI*) is fourth-highest in OECD.